It’s time again to review rules for non-conventional sources of down payment on home purchases. Below are guidelines that are especially important for home buyers who haven’t saved as much as they’d like to put a down payment on a home and need another approach.
GIFT FUNDS: You can use gift funds from a family member as money for a down payment. You and the family gift donor must both sign a lender Gift Letter verifying the funds are in fact a gift. For most loans the donor must also provide proof of their ability to gift, usually in the form of a bank statement. As for tax implications, Gift Tax is imposed on donor, not receiver. Any individual can gift any other individual $13k per year tax free. So a married set of parents can each give $13k to their single child for a total of $26k. Or that same set of parents could gift to a married couple for a total of $52k. Then the balance needed for any gift funds beyond those amounts can still come tax free to the donor under the $5m lifetime exclusion for gift tax under 2012 estate tax law. The donor must complete IRS form 709 to keep a tally of gift funds that fall under the lifetime exclusion (which is normally $1m over a lifetime but is $5m for 2011-2012).
401(k) LOAN: You may borrow up to 50% or $50,000 of your 401(k) funds for a down payment, whichever is less. Rates on 401(k) loans are set by the institution that administers the 401(k), and today are between 4.75% and 5.25% amortized over 30 years. On a $50,000 loan at highest-case 5.25%, the payment would be $276. This is far more advisable than paying taxes and penalties for early withdrawal. The part you borrow is removed from whatever it’s invested in and placed in an interest-bearing account. So you lose some but not all of your ability to stay invested. If you leave the employer administering the 401(k), you have 90 days to repay the remaining loan balance or it’s counted as an early distribution, subject taxes and penalties. CRITICAL: you must borrow off of your current employer’s 401k. If you have a 401k from a former employer, it must be rolled over into the new employer’s 401k plan to be eligible for a loan.
IRA WITHDRAWAL: You can withdrawal $10,000 in down payment funds from a traditional IRA penalty free but not tax free. So you’ll get the whole $10,000 when you take it out, but you’ll have to pay federal and state capital gains taxes (about 35% total) on the next tax filing cycle. If you liquidate more than $10,000, 20% of the overage will be withheld for taxes (but taxes will eventually be about 35%). On top of this, federal and state penalties are about 12.5% on anything above $10,000.
ROTH IRA WITHDRAWAL: Roth IRA contributions are made with after-tax dollars so you can withdraw your contributions at any time for down payment (or any other reason) with no tax liability. But if you withdraw any capital gains your Roth accumulates beyond your contributions, there are more rules. When buying a home, you can withdrawal $10,000 of capital gains with no taxes or penalties. After that initial $10,000, any withdrawals from capital gains are taxed as income and have a 10% penalty unless two things are true: (1) the withdrawal occurs after five full “tax years.” A “tax year” begins January 1 of the contribution year, even if the contribution is made on December 31. (2) You’re a first-time homebuyer, which is defined as someone who hasn’t owned a principal residence for three years. Owning a rental property or a vacation home doesn’t disqualify you. Also, if you’re looking to help a spouse, child, or grandchild who is a first-time homebuyer, you can make a tax-free, penalty-free Roth IRA withdrawal of up to $10,000.
Always consult tax, mortgage, financial planning, and estate advisors on the right approach for your specific profile.